Infrastructure M&A: Journey to the non-core

Institutional investors are increasing their investments in core infrastructure and aggressively competing with funds. This increased appetite has forced fund managers to search for riskier assets outside of the mainstream.

Over the past seven years, institutional investors and funds have been battling each other for the most prized infrastructure assets. This competition has led to a steep increase in both European infrastructure M&A and a corresponding drop in returns from such assets.

In the main, these contests have been over "core" infrastructure—defined as regulated, monopolistic energy, transport and environmental assets. These are viewed as the safest and most attractive way for institutional investors to secure the types of long-term yield required to match their liabilities.

As a result, infrastructure funds that have traditionally been active in the sector are being pushed to work harder to source the types of deals that will generate the returns that they have enjoyed in the past—and that their limited partners have come to expect.

Corporate-owned, neglected core infrastructure assets can still provide some of the deal flow for infrastructure funds, but the search for an adequate level of exit potential that provides robust returns has increasingly pushed asset managers into areas of "non-core" infrastructure. These assets are seen as having greater market risks, such as power price exposure, short-term contracts, geopolitical risks, less sophisticated regulatory regimes and/or contract renewal risks, but they often offer better returns than core assets.

Although this recent trend towards non-core investing by infrastructure funds has been noted, the maturing nature of the non-core infrastructure space has now opened the door for institutional investors to move into the space. Institutionals have, like their more nimble asset manager counterparts, increased their risk appetites and are now prepared to acquire non-core assets and to do so in an increasingly competitive fashion. With allocations to the infrastructure asset class projected to double over the next decade and the competition for core infrastructure showing no sign of receding, this non-core shift will only accelerate in the coming years.

This report, developed with the Inframation Group, explores the shift in infrastructure dealmaking by institutional and infrastructure investors alike in the non-core infrastructure space. We investigate where the key battlegrounds are in the increasingly competitive infrastructure landscape; the opportunities and challenges for both sets of investors; and we ask how funds can survive and thrive in this brave new world of infrastructure dealmaking.

The number and value of investments in core infrastructure rose in 2016, compared with 2015, with 88 deals (up 15 per cent) valued at €19.4 billion (up 19 per cent)

Investment in non-core European infrastructure more than tripled over the last seven years, from €4.23 billion in 2010 to €14.46 billion in 2016. Deal volume rose by 315 per cent from 13 deals in 2010 to 54 in 2016

Between 2010 and 2016, more than half (53 per cent) of all non-core infrastructure investment was made by infrastructure funds

In value terms, transport (41 per cent) and power (28 per cent) are the main sectors for non-core infrastructure investment, with assets such as car parks, motorway services and midstream oil and gas assets leading the way

Western Europe is the main region for non-core investment, with the UK market leading the way. From 2010 to 2016, non-core investment levels in the UK market amounted to €16.67 billion—double that of Germany, the second-most popular market for non-core capital

Despite the UK's impending exit from the EU, UK investment levels are forecast to hold up in the coming years

Infrastructure funds are increasing their capital allocations to non-core sectors, although in doing so they will need to take on increased risk and operate outside an established regulatory environment. There are six steps that investors should take to get the best out of the non-core market.

Methodology

For this report, InfraDeals analysed European M&A transactions that reached financial close in the infrastructure sector between the years 2010 and 2016. InfraDeals is concerned solely with infrastructure transactions that have been financed with private sector equity investment. For the purpose of this report, M&A transactions were categorised as the sale of equity in operational assets across the transport, power, environment and telecommunications sectors in Europe.

Glossary

Institutional investors: These include insurance companies, public and private pension funds, and sovereign wealth funds.

Core infrastructure: This includes assets with the following characteristics:

• Generation facilities that are operational and have a long-term off-take agreement with an investment-grade counter-party, or gas or electricity distribution businesses operating in a stable regulatory environment
• When the asset is a public-private partnership (PPP) and/or its revenue stream is contracted on a long-term basis with an investment-grade counter-party
• Assets that provide essential services and have a monopolistic position in their sector and/or region

Non-core infrastructure: These assets lack the properties noted above, and are more exposed to factors such as demand and construction risk as well as increased competition.

Examples of core infrastructure assets include UK-regulated water utilities or the recently sold Nice and Lyon airports in France. Non-core infrastructure examples include airport equipment leasing or crematoria businesses.